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In California divorce cases parties often overlook the tax treatment of their proposed actions when negotiating settlement agreements. A husband might say, "I will pay you more spousal support than child support because our child is turning eighteen (18) soon and child support will terminate." A wife might say, "I will pay you $100,000.00 if you just waive your right to spousal support." In order to compromise an attorney might propose, "Let's start with a high spousal support amount for the first year and step the amount down as time goes on." However, family law litigants should think carefully about these proposals because they all contain hidden tax consequences.

In a recent post-judgment modification case, Alice requested an increase in the amount of monthly spousal support she received from her former husband, John. The parties reached an out of court settlement and John agreed to pay Alice a lump sum payment of $350,000 in exchange for her agreement to waive any future right to spousal support. After the parties formalized their agreement, John paid Alice $350,000. As John was used to deducting his monthly spousal support payments on his tax returns, he deducted the $350,000 spousal support payment on his return the following year. The IRS disallowed all but one month's worth of spousal support as a deduction for John. On appeal, the tax court held that a lump sum settlement of future spousal support was non-deductible because the obligation to make the payment would not have expired in the event of Alice's death.

Generally, Congress draws a clear line between child support, spousal support, and property settlements in order to ensure that parties can only deduct payment of spousal support. Further, Congress has structured the law to ensure parties cannot structure property settlements that are disguised as spousal support. As is evident in this dramatic example, the ability to deduct $350,000 of spousal support versus being barred from such a deduction results in a radically different amount of money paid out-of-pocket. On the other side of this case, Alice received $350,000 in non-taxable spousal support which otherwise would have been taxed to her at her normal rate. Alice received substantially more net income than she otherwise would have.

In sum, taxation and family law is a complicated crossover of two different areas of law. Your property and support agreements may involve serious tax implications and therefore, it is always advisable to consult with a knowledgeable family law attorney regarding your divorce issues.

During this time of year many people get motivated to clean out their closets and clean up their finances. If you are considering pursuing a divorce this year, you will also want to consider using some of that "spring cleaning" energy to prepare for the changes to come. There are a lot of small steps potential family law litigants can take in order to make the divorce process run more smoothly and affordably.

Get your financial documents in order

With tax season in full swing, there is no better time to collect and organize all of your financial documents. Sit down with your spouse and figure out what each of you earns and how much the family spends each month on living expenses. In addition, discuss all of your joint and separate assets and debts. Collecting documentation on these topics such as income, expenses, assets and debts will save you substantial time and money in the divorce process. At the outset of every divorce case, both parties are required to set forth all material facts and information regarding their finances. Gathering these documents and information ahead of time will jump start your case.

Check into your credit score

In order to start a separate financial life from your spouse you may need to obtain your own loans and credit cards. If there is an error in your credit report, it is better to address it before your potential new creditors discover it. Typically repairing your credit can take a significant amount of time. If you are newly divorced, you will likely need credit immediately for a potential refinance, purchasing your own vehicle, or starting a line of credit. Therefore, it is always a good idea to check your credit sooner rather than later.

Get credit cards and bank accounts set up in your name

One of the most expensive and fruitless endeavors in a family law case is the issue of credits/reimbursements for post-separation expenditures. Once you and your spouse have separated, it is much cleaner for the both of you to begin using separate bank accounts and credit cards. If you untangle your finances at the beginning of the case, you can avoid analyzing mountains of paperwork attempting to decipher who spent what post-separation. If your spouse is not aware that you will be filing for divorce, it is advisable to open new accounts with different entities than the ones which hold your current joint accounts.

Begin to process your emotions

Divorce is an extremely emotional process for a majority of parties. However the process of divorce should be logical and analyzed from a financial standpoint. In order to separate your emotions from your financial decisions, you might want to begin processing the idea of divorce early. If helpful, begin speaking with a licensed mental health professional to deal with your emotional needs. Venting to your divorce attorney about marital discord is less useful and much more expensive than a weekly therapy session.

The Defense of Marriage Act (DOMA) was enacted on September 21, 1996 and permitted the states to refuse to recognize same-sex marriages legally entered into in other states. This means that under DOMA, if a same-sex couple who legally married in Hawaii moved to California, California would not be required to recognize the marriage and provide state benefits otherwise provided to married couples. In June 2013, the Supreme Court of the United States declared DOMA unconstitutional. In the aftermath of that landmark decision many same-sex couples are questioning whether they will receive any retroactive relief for the various benefits they were deprived of for nearly seventeen years.

New York legalized same-sex marriage in June 2011 and extended equal rights under estate tax law to legally married same-sex couples in July that same year. Estate tax rights were even extended to those married in other states before New York legalized same-sex marriage. However, federal laws prevented New York from implementing any retroactive application of the estate tax law. This problem came to light when Edie Windsor sued the IRS for denial of her right to inherit granted to other married couples. In 2009, Edie paid $363,000 in federal taxes upon the death of her spouse. As their marriage was not federally recognized under the tax code, she was unable to reap estate tax benefits available to married couples. The Supreme Court held Edie was entitled to a tax refund.

Similarly, since Massachusetts issued the first marriage license in the United States to a same-sex couple in 2004, wedded same-sex couples have been unable to file joint federal tax returns. Although a same-sex couple may be married under the laws of their home state, they were unable to claim any federal tax benefits. Now that such federal tax laws have been overturned, same-sex couples question whether they can retroactively realize federal tax benefits back to the date of their marriage.

In general, a tax refund can be claimed within three years of filing the incorrect tax return or within two years of the overpayment. Under this common rule, same-sex married couples may be able to collect overpaid taxes for the past three tax years. Some have rumored that the IRS will extend this typical statue of limitations to allow same-sex married couples to collect tax refunds even further back.

With Tax Day (April 15th) near approaching, both CPAs and divorce attorneys alike are likely receiving an influx phone calls from clients regarding the tax implications of spousal support, often referred to as alimony.

Generally, spousal support is considered to be tax-deductible to the spouse who is paying the support. On the other hand, spousal support must be reported as taxable income to the spouse who is receiving the support. For individuals who stay at home to care for young children and have no other source of income other than the receipt of spousal support after divorce, the tax hit due April 15th might pose quite a significant financial concern.

Although not commonly known, spousal support payments can in fact be designated as non-taxable and non-deductible so long as both parties agree and such an agreement is pursuant to a divorce or separation instrument. During divorce settlement negotiations, agreeing to designate spousal support as non-deductible and non-taxable may be suggested by divorce attorneys in situations where the paying spouse does not want/need the tax deduction, and the recipient spouse does not want to report the income. For instance, as described above, the receiving spouse may not want to report the income so as to avoid the tax hit at the end of the year. Lolli-Ghetti v. Lolli-Ghetti, on the other hand, is an example of a divorce case where the payee spouse did not need the tax deduction because he was a resident of Monaco and the bulk of his income was therefore not subject to federal, state and local income taxes.

A decree requiring a spouse to make payments for the support or maintenance of the other spouse (as defined in 26 U.S.C. §71 (b)(2)).

The instrument must contain a clear and explicit designation that the parties have elected for the spousal support to be non-taxable to the payee and thus excluded from payee's gross income and non-deductible to the payor. It is also important to note that a copy of the instrument, which contains the above designation of spousal support payments as non-taxable/non-deductible, must be attached to the payee's tax return (Form 1040) for each year that the designation applies to.